Sharing the Financial Burden
Risk transfer is about deciding who will bear the risks that you have identified and that you can't completely control or avoid.
"The family business risk transfer strategies vary from retaining exposure to transferring most of the exposure." Schwerzler has been studying and advising family businesses for more than 40 years and he is the founder of the
Family Business Institute
For instance, a heavy equipment dealer might have several field service vehicles whose drivers have an excellent safety record. They are older but have been well maintained even though their book value is much reduced. They travel country roads where the risk of collision is less. With a lower probability of collision loss, and a manageable value of loss, the dealership might decide to drop collision coverage completely. Here, the dealership's risk transfer strategy is to retain the risk. The dealership will pay for collision damage with its own funds.
Or, it might decide to carry some collision coverage, but reduce the premiums by having a high deductible. In this case , it's risk transfer strategy is to retain part of the risk [the deductible] and transfer the rest to the insurance company.
When the risk transfer decision is to transfer part or all of a risk, there are options. Insurance is one, but there are also non-insurance options to consider.
- A dry cleaner could decide to sell its fleet of delivery vans and hire a local delivery company to provide the service. It has eliminated risk of collision, and risks of owning and maintaining the fleet.
- An airline charter company leases its aircraft and contracts for maintenance from a specialized operator in the region.
- A retailer decides to carry certain items on a special-order basis instead of keeping them in stock. Lower inventory means lower exposure to risk (and reduced operating costs since less space is needed to be rented, heated).
Contracting out or out-sourcing have been very popular in many industries in recent years, both for risk transfer strategy and operations management reasons.
Insurance Is The Most Common Risk Transfer Strategy
By insuring a property, you pay a relatively small amount in premium rather than run the risk of not protecting yourself against the possibility of a much larger financial loss. Your risk management strategy is to transfer most of the risk of loss to the insurance company.
Only you and your advisors can decide how much risk you and your family business can carry and how much should be transferred through non-insurance options or to insurance companies. And even then, some of the decision is not entirely up to you.
- Workers Compensation coverage is usually required by law.
- Business vehicles must be insured in most jurisdictions
- Contractors must carry liability insurance in many jurisdictions
- Most lenders require coverage, payable to them first, on properties they finance in order to protect their financial interest
Many family businesses do not have the cash or borrowing capacity to even consider retaining any appreciable degree of risk by not insuring. For them, risk management will involve mostly risk transfer via insurance and non-insurance options.
Let's consider the case of a family business that otherwise seems to be cash-rich and that might consider a risk management strategy of retaining risk. Is this wise?
A loss would reduce the cash reserves. Now the reserves are not available to support operations, to protect the business against cyclical downturns, to protect against a second disaster or loss. And the reserves are not available to support the family members who depend upon the family business for their livelihood. Nor are they available to enable funding transfers from one generation to the next or to help employees / managers assuming ownership if the family does not have successors.
In our experience, there is almost always a better risk management strategy in a family business than keeping the cash resources on hand for self-insurance!
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